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Are there any corporate law cases that deserve a book all to themselves?

At Public Discourse, Matthew Franck comments on a number of books each of which focuses on a single constitutional law case: 

... as I look around my shelves, I see a great many books on American political thought and constitutional law that have influenced my own work as a teacher and scholar of those subjects. The books I describe below have something in common: each is a deep reconsideration of a famous U.S. Supreme Court decision, with unexpected insights not only about the law but about the shape of our political order.

Which got me to wondering whether one could write similar books about cases from an important area of the law, such as corporate law. Any suggestions?

Who is in control? Delaware corporate law's answer

Under Delaware law, a shareholder is deemed to have control if the shareholder either owns a majority of the voting stock or exercises control over corporate decision making.[1] If the shareholder owns less than 50 percent of the voting stock, plaintiff must show evidence of actual control of corporate conduct.[2] Consequently, for example, the Delaware supreme court in Kahn v. Lynch Communication Systems, Inc.,[3] held that a 43.3 percent shareholder exercised control, not based on the number of shares it owned, but because the board of directors deferred to the shareholder’s wishes.

In an interesting new case, Voigt v. Metcalf,[4] plaintiffs claimed that private equity firm Clayton, Dubilier & Rice (“CD&R”) controlled  NCI Building Systems, Inc. (the “Company”), pointing to such factors as CD&R’s control of 34.8% of the Company’s voting power, the presence of four CD&R insiders on the Company’s twelve-member board of directors (the “Board”), CD&R’s relationships of varying significance with another four directors, and a stockholders agreement that gave CD&R contractual veto rights over a wide range of actions that the Board could otherwise take unilaterally. Plaintiffs who were minority shareholders of the Company claimed CD&R had used its control of the Company to effect a merger between the Company and a CD&R affiliate.

The defendants moved to dismiss, arguing that CD&R did not have control of the Company and, accordingly, owed no fiduciary duties to the minority. The court noted that because CD&R’s 34.8% ownership stake was than a majority, plaintiffs could only prevail if they “allege facts that support a reasonable inference that the defendant in fact ‘exercise[d] control over the business affairs of the corporation.’”

A plaintiff can plead that a defendant had the ability to exercise actual control by alleging facts that support a reasonable inference of either (i) control over the corporation’s business and affairs in general or (ii) control over the corporation specifically for purposes of the challenged transaction.

To plead that the requisite degree of control exists generally, a plaintiff may allege facts supporting a reasonable inference that a defendant or group of defendants exercised sufficient influence “that they, as a practical matter, are no differently situated than if they had majority voting control.” One means of doing so is to plead that the defendant, “as a practical matter, possesses a combination of stock voting power and managerial authority that enables him to control the corporation, if he so wishes.”

To plead that the requisite degree of control existed for purposes of a particular transaction or decision, a plaintiff does not have make such a pervasive showing. Rather, the plaintiff must plead facts supporting a reasonable inference that the defendant in fact exercised actual control “with regard to the particular transaction that is being challenged.”

“The question whether a shareholder is a controlling one is highly contextualized and is difficult to resolve based solely on the complaint.” “[T]here is no magic formula to find control; rather, it is a highly fact specific inquiry.”

Under the Company’s shareholders agreement, CD&R had a right to appoint four out of the Company’s twelve directors. Even though CD&R’s representatives were less than a majority of the board, the power to appoint them was “an indication of control.” In addition, CD&R has various business relationships with four of the nominally independent directors, which were sufficient to infer at this stage of the proceeding that those directors were beholden to CD&R, which gave CD&R effective control over two-thirds of the board.

In discussing CD&R’s stock ownership, the court acknowledged that there is no “linear, sliding scale approach where by a larger share percentage makes it substantially more likely that the court will find the stockholder was a controlling stockholder.” Nevertheless, “a relatively larger block size should make an inference of actual control more likely, even though the interplay with factors makes the correspondence difficult to perceive.” This is so not only because a large blockholder only needs pick up the votes of a small number of shareholders to prevail, but also because a large blockholder is likely to have significant influence on the board,

In addition to various other minor factors, the court noted that the stockholder agreement contained provisions that cut in opposite directions. On the one hand, the agreement ensured board representation for the minority shareholders. On the other hand, the agreement gave CD&R a de facto video over a number of corporate actions that ordinarily would be left to the discretion of the board.

The consent rights encompassed both significant corporate and financing transactions, as well as more basic corporate governance issues like increasing the size of the Board or amending the bylaws. These blocking rights weigh in favor of an inference that CD&R exercised control over the Company generally by giving CD&R power over the Company beyond what the holder of a mathematical majority of the voting power ordinarily could wield.

Contractual rights that do not amount to a significant source of general control can, depending on the circumstances, give rise to an inference of transaction-specific control, because the holder of the contract rights can use them to channel a corporation into a particular outcome by blocking other paths. Although a blocking right standing alone is unlikely to support a reasonable inference of control, in the context of a particular factual scenario, it can be a highly effective form of control. The paradigmatic example involves a cash-burning, asset-light company that does not yet generate sufficient revenue to finance its business plan and has reached the point where it requires external financing. Under those circumstances, a party that has a veto right over the company’s access to financing can “sit on the company’s lifeline, with the ability to turn it on or off.” When cash is like oxygen, the ability to choke off the air supply is a strong indicator of control, particularly if there are factual allegations (and later evidence) that the party holding the veto right used it to force the company into a vulnerable position.

Ten best securities and corporate law articles of 2019

The list is out. Congratulations to the winners, especially Elizabeth Pollman who had two articles make the list: the rare double!

Have you used my Concepts and Insights treatise on Corporate Law?

I'm working on a new edition of my Foundation Press Concepts and Insights treatise on Corporate Law. If you've used it and have suggestions or corrections, please let me know. Thanks.

Conducting the Annual Shareholder Meeting during the COVID19 Pandemic

The season for annual shareholder meetings is now well underway, but many states have stay-at-home mandates or suggestions limiting the size of public meetings. So how will corporations safely and legally conduct a shareholder meeting during the pandemic? And what will the changes made this year bode for the future?

In 2000, Delaware amended the General Corporation Law to permit virtual shareholder meetings. Section 211(a)(1) thus provides that:

Meetings of stockholders may be held at such place, either within or without this State as may be designated by or in the manner provided in the certificate of incorporation or bylaws, or if not so designated, as determined by the board of directors. If, pursuant to this paragraph or the certificate of incorporation or the bylaws of the corporation, the board of directors is authorized to determine the place of a meeting of stockholders, the board of directors may, in its sole discretion, determine that the meeting shall not be held at any place, but may instead be held solely by means of remote communication as authorized by paragraph (a)(2) of this section.

Section 211(a)(2) provides an alternative, pursuant to which the board may authorize shareholders who are not present at a physical meeting of the shareholders to participate in such a meeting by "remote communication." Until recently, this sort of hybrid meeting was far more common than a purely virtual meeting. But there was a trend towards virtual meetings: "Broadridge Financial Solutions, Inc. (Broadridge), has reported a dramatic increase in the prevalence of virtual-only meetings, going from hosting just one virtual-only meeting in 2009, to 53 meetings in 2014, and then increasing to 90 and 155 meetings in 2015 and 2016, respectively." Lisa A. Fontenot, Public Company Virtual-Only Annual Meetings, 73 Bus. Law. 35, 35–36 (2018). And, as noted, the novel coronavirus may change all of that.

Delaware Governor John Carney yesterday (4/6/2020) issued an emergeny order intended to substantially facilitate the use of virtual shareholder meetings. The order notes that:

WHEREAS, § 222(c) of Title 8 of the Delaware Code allows for adjournments of stockholder meetings, but does not address the method of adjournment of a meeting noticed for a physical location in the case of a public health threat and concomitant restrictions on personal mobility and travel; and

WHEREAS, § 232 of Title 8 of the Delaware Code provides that notice of stockholder meetings may be given by mail, courier service or electronic mail, but also suggests that there may be other means by which notice may be given effectively to stockholders; and

WHEREAS, during the COVID-19 pandemic, the Securities and Exchange Commission is allowing reporting companies to provide certain notices to stockholders via the companies’ required public filings and a press release.

The order then provides that:

With respect to a corporation subject to the reporting requirements of § 13(a) or § 15(d) of the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder:

i. if, as a result of the public health threat caused by the COVID-19 pandemic or the COVID-19 outbreak in the United States, the board of directors wishes to change a meeting currently noticed for a physical location to a meeting conducted solely by remote communication, it may notify stockholders of the change solely by a document publicly filed by the corporation with the Securities and Exchange Commission pursuant to § 13, § 14 or § 15(d) of such Act and a press release, which shall be promptly posted on the corporation’s website after release; and

ii. if it is impracticable to convene a currently noticed meeting of stockholders at the physical location for which it has been noticed due to the public health threat caused by the COVID-19 pandemic or the COVID- 19 outbreak in the United States, such corporation may adjourn such meeting to another date or time, to be held by remote communication, by providing notice of the date and time and the means of remote communication in a document filed by the corporation with the Securities and Exchange Commission pursuant to § 13, § 14 or § 15(d) of such Act and a press release, which shall be promptly posted on the corporation’s website after release.

As K&L Gates observes, a corporation wishing to take advantage of this option must:

• Implement reasonable measures to verify that each person deemed present and permitted to vote at the virtual meeting is a stockholder or proxyholder;
• Implement reasonable measures to provide stockholders and proxyholders a reasonable opportunity to participate in the virtual meeting and vote on matters, including an opportunity to read or hear the proceedings of the meeting substantially concurrently with such proceedings; and
• Maintain a record of a stockholder or proxyholder’s vote or other action taken at such meeting.

K&L Gates also notes that:

• If the corporation has already mailed the notice of meeting, and the corporation has sufficient time to give its stockholders 10 days’ notice of the virtual meeting, a new notice ordinarily must be distributed to stockholders by a physical mailing or by e-mail [1]. However, pursuant to the Order, any Delaware corporation that is subject to the reporting requirements of §13(a) or §15(d) of the Exchange Act may notify stockholders of the change of the format of the meeting solely by filing a document with the SEC and issuing a press release, which shall be promptly posted on the corporation’s website after release. The notice should contain the information required for a notice of a virtual meeting described above.
• If the corporation has mailed the notice of the annual meeting and there are fewer than 10 days’ before the meeting or it is otherwise impracticable to convene a currently noticed meeting, the meeting could be held but adjourned to another place (i.e., a virtual location). Ordinarily, notice of an adjourned meeting is not required so long as the date, time and place or means of remote communications by which stockholders and proxyholders may be deemed to be present in person and vote at such adjourned meeting are announced at the meeting at which the adjournment is taken and the adjournment is for no more than 30 days. Pursuant to the Order, a public company also may adjourn the meeting by providing notice of the date and time of the virtual meeting and the means of remote communication by which stockholders may participate in the meeting solely by filing a document with the SEC and issuing a press release, which shall be promptly posted on the corporation’s website after release.
• Where there is insufficient time to send out a new notice and/or it is impracticable to adjourn or postpone the meeting, another option for corporations is to simply hold the physical meeting as planned, but to stream the meeting over the internet so that stockholders have the opportunity to hear or view the meeting remotely. Because the meeting is considered a meeting held at a physical place, stockholders, who do not come to the physical meeting but participate in the webcast, must submit their proxies in advance of the meeting according to the instructions set forth in the original proxy materials in order to have their votes count for quorum and voting purposes.

The SEC guidance referred to above is available here.

Some companies have hesitated about moving to virtual meetings, because shareholder advisory service Glass Lewis and some large institutional investors opposed virtual-only meetings. However, Glass Lewis has suspended that policy for the duration (2020 WL 1430493):

The firm, which is the second-largest advising institutional investors on proxy votes, said in a blog post that online-only meetings offer "compelling advantages" to both companies and shareholders given the situation regarding COVID-19. Its approval of the option extends to June 30.

"We do not believe discouraging virtual-only meetings during this time serves the interests of shareholders or companies," Glass Lewis said in the post on its website, noting that moving meetings online will offer certainty and continuity in timing, agendas, and voting.

Some investors, including the Council of Institutional Investors, oppose virtual-only shareholder meetings as lacking the same opportunities to hold management accountable and ask questions as in-person gatherings. ...

Glass Lewis's policy update says the firm will take the pandemic into account during the 2020 proxy season when applying its virtual-only meeting policy and generally refrain from voting against governance committee members for this reason as long as the company says it moved the meeting online because of COVID-19 or similar rationale. Reviews will be case-by-case and note whether companies say they'll return to in-person or hybrid meetings in the future. 

The Council of Institutional Investors (CII) has likewise suspended its opposition to virtual only meetings, albeit only for the current proxy season:

“Given coronavirus concerns,” said CII Executive Director Ken Bertsch, “it is entirely reasonable that some companies will go to virtual-only annual meetings.”

Bertsch added that CII hopes that companies “will make it clear that this decision is a one-off, tailored for current circumstances.” He also urged companies to follow best practices “for making virtual meetings participatory, replicating as much as possible the experience of an in-person meeting.” And he said that “companies that do hold in-person meetings should be flexible with shareholder proponents on presentation of shareholder proposals, accommodating travel restrictions that they may face.”

CII generally has opposed virtual-only shareholder meetings, in favor of a hybrid approach.

How will it work? Broadridge is the principal stockholder service company and had been active in both virtual and hybrid meetings for many years. They provide online platforms for conducting a virtual meeting:

They also provide a useful white paper on best practices for conducting a virtual meeting. Some key best practices are also available from CII:

CII’s October 2017 publication, Build a Better Meeting, offers guidance on creating shareholder-oriented meetings, including virtual components. The publication urged that virtual meetings include:

• • A live audio and video feed of all key company representatives in attendance, including, at a minimum, the chair, CEO, any lead/presiding director, chairs of key board committees and the corporate secretary.
  • A continuously updated list of all shareholder questions submitted both before and during the meeting, accompanied by clear indication of any subsequent deletion or re-ordering in the queue.
  • A comprehensive Q&A tool allowing the shareholder to:
    • Submit a question
    • Track its prioritization in the queue
    • Present the question virtually, including through the use of a shareholder-provided webcam or phone
    • Instructions or a link to written responses to unanswered shareholder questions, made available within 72 hours of the meeting’s conclusion.
    • Basic information about the meeting known to the company, which may include a list of attendees, the number of shares represented at the meeting and preliminary vote counts.

One key issue will be the requirement in Rule 14a-8 that proponents of a shareholder proposal must be present at the meeting. David Hooper and Lynne McMahan explain that 

The SEC guidance also provides direction to companies and shareholders regarding the presentation of shareholder proposals at annual meetings for the 2020 proxy season. Under Exchange Act Rule 14a-8(h), shareholders or their representatives are required to appear in person and present their proposals at the annual meeting. In light of the possible difficulties of appearing in person to present their proposals (whether because of COVID-19-related travel concerns or because of a change to a virtual meeting), the SEC encourages companies, to the extent feasible under state law, to provide shareholders or their representatives with the ability to present their proposals through alternative means, such as by phone, during the 2020 proxy season. Companies in this situation should coordinate and communicate in advance with shareholders regarding the means of presenting their proposals and any necessary technical requirements or limitations.

Furthermore, to the extent a shareholder or representative is not able to attend the annual meeting and present the proposal due to the inability to travel or other hardships related to COVID-19, the SEC considers this to be “good cause” under Rule 14a-8(h), and therefore, issuers cannot assert a shareholders’ absence as a basis under Rule 14a-8(h)(3) to exclude a proposal submitted by the shareholder for any meetings held in the following two calendar years.

Hooper and McMahon also offer some best practices:

• Companies should engage an experienced remote communication services provider (such as Broadridge or Computershare) to host the virtual or hybrid meeting.

• Companies must ensure that the remote communication method allows shareholders to vote, ask questions and make comments, hear answers to questions, and otherwise exercise all of the rights shareholders have under state law for participation in shareholder meetings.

• Companies should develop protocols for facilitating the process for shareholder proposal proponents to present their proposals.

• Companies must also ensure that the technology platform used to conduct the virtual meeting will accommodate all of the shareholders, board members, members of management, and other persons participating in the meeting.

• Companies also should make shareholders aware of the procedures necessary to access and participate in the virtual meeting.

Finally, blog friend Keith Paul Bishop has a useful discussion of the state of the issue in California.

Kevin LaCroix discusses "Cash-Crunched Companies Face Insolvency; Will Directors Face Claims?"

From D&O Diary:

The current disruption to normal business operations across the country means that many businesses will soon be under significant financial pressure, if they are not there already. As their companies edge toward insolvency, directors are going to have to make significant decisions about the companies and their operations. Boards may be concerned, as they make critical and difficult decisions, that creditors or others may later attempt to claim that they violated their legal duties.  This concern in turn leads to the question about exactly what duties directors face as their companies approach insolvency.

In general, directors of solvent companies do not owe creditors fiduciary duties. A solvent company’s duties to its creditors are instead defined in other ways – for example, by the law of contract, bankruptcy laws, general commercial law, and creditors’ rights.

Whether companies take on fiduciary duties to creditors when they approach the “zone of insolvency” is very much a matter of state law. Under the law of Delaware, the state under whose laws many companies are organized, “duties of directors are fundamentally the same whether a corporation is solvent, insolvent, or trending towards insolvency,” according to March 26, 2020 memo from the Stinson law firm entitled “The Director’s Dilemma: An Overview of Director Fiduciary Duties when Insolvency Looms” (here), “ with the goal of pursuing ‘value maximizing strategies for the benefit of the corporation and its ‘residual stakeholders.’”

There's much more, including  when a company becomes insolvent for purposes of Delaware law.

Although it is now somewhat dated, those readers interested in this issue may wish to consult my article on the subject: 

Bainbridge, Stephen Mark, Much Ado About Little? Directors' Fiduciary Duties in the Vicinity of Insolvency. Journal of Business and Technology Law, Forthcoming; UCLA School of Law, Law-Econ Research Paper No. 05-26. Available at SSRN: https://ssrn.com/abstract=832504

When Is An Emergency An Emergency For Purposes of Emergency Bylaws?

Keith Paul Bishop has the answer.

Governor Newsom suspends requirement that shareholders consent to virtual-only annual shareholder meetings

But does he have authority to do so? Here.

My WLF Legal Pulse column on federal forum selection clauses and Salzberg v. Sciabacucchi is now up

You can download it here.

The Delaware Supreme Court's federal forum selection clause decision in Salzberg v. Sciabacucchi

I've just finished a short piece on Salzberg v. Sciabacucchi, (Del. Mar. 18, 2020), for the Washington Legal Foundation. Ann Lipton has written a lot on the issues involved and her initial blog post on the case is well worth reading. As somebody who is generally regarded as a nexus of contracts fellow, I was particularly struck by her discussion of the prominent ways in which corporate theory has featured in the litigation:

I think the contrast between the Supreme Court and Chancery decisions as a matter of corporate theory are quite striking.  The Chancery decision is a fairly stark example of the concession theory of the corporation: Laster makes very clear that Delaware, as sovereign, is intimately involved in establishing corporations, designing their operations, and articulating their limits.  The Supreme Court, by contrast, is a model of contracts theory; it treats the corporation as simply a private arrangement among its constituents, with few prohibitions on what that arrangement may entail.  I have been thinking about designing a corporate theory seminar; if it comes to fruition, I’ll likely include excerpts of both opinions.

First legal test for California board of directors gender quota law today

Keith Paul Bishop reports:

Last August, I reported on the filing of a taxpayer challenge to California's Board Gender Quota Law.  Crest v. Padilla, Cal. Super. Ct. Case No. 19STCV27561. ...

The Secretary of State's demurrer will be heard on Monday by Superior Court Maureen Duffy-Lewis.  Secretary Padilla faults the plaintiffs with failing to plead specific facts alleging illegal expenditures sufficient to establish taxpayer standing under Section 526a of the California Code of Civil Procedure.  ... 

From the the cryptozoological wing of the corporate law zoo

Famed Delaware Chancellor William Allen once compared the corporate law doctrine of waste to one of the most famous cryptids:

Absent an allegation of fraud or conflict of interest courts will not review the substance of corporate contracts; the waste theory represents a theoretical exception to the statement very rarely encountered in the world of real transactions. There surely are cases of fraud; of unfair self-dealing and, much more rarely negligence. But rarest of all-and indeed, like Nessie, possibly non-existent-would be the case of disinterested business people making non-fraudulent deals (non-negligently) that meet the legal standard of waste!

Steiner v. Meyerson, CIV. A. 13139, 1995 WL 441999, at *5 (Del. Ch. July 19, 1995)

Vice Chancellor Glasscock has gone him one better:

In the cryptozoological division of equity's menagerie are a number of rarae aves and chimeras—some, perhaps, not so chimerical as once thought. One unusual denizen is on display here. A stockholder brought a purported derivative action, alleging that insiders had structured an acquisition unfair to the corporation. The action withstood a motion to dismiss, and the corporation formed a special litigation committee of the board to evaluate the claim. I then stayed the matter for several months, to allow the special litigation committee, assisted by its own counsel, to consider the cause of action. Ultimately, the special litigation committee found that it was in the corporate interest that the cause of action be pursued, and determined that that asset would best be monetized on behalf of the corporation by allowing the original plaintiff to proceed, derivatively.

In re Oracle Corp. Derivative Litig., CV 2017-0337-SG, 2019 WL 6522297, at *1 (Del. Ch. Dec. 4, 2019)

I've been at the corporate law gig for 36 years as student, practitioner, author, and professor and in all that time I have never encountered a case in which the SLC not only though the suit should go forward but also that it should go forward under plaintiff's control. 

 

Frankly, I would be less surprised to find myself sharing a cab with Bigfoot.

"Religious Sincerity in Corporations"

Ben Edwards:

California Western's Catherine Hardee, recently posted her paper Schrodinger's Corporation: The Paradox of Religious Sincerity in Heterogeneous Corporations to SSRN.  It's a fascinating piece and has already been featured on Ipse Dixit if you're curious about a podcast version.

Her abstract sets the key problem out well:

Consider a corporation where one group of shareholders holds sincere religious beliefs and another group of shareholders does not share those beliefs but, for a price, will allow the religious shareholders to request a religious exemption to a neutrally applicable law on behalf of the corporation.  The corporation is potentially both religiously sincere and insincere at the same time. A claim by the corporation for a religious accommodation requires the court to solve the paradox created by this duality and declare the corporation, as a whole, either sincere or insincere in its beliefs. While the Supreme Court and scholars have noted some of the particular issues raised when determining the religious sincerity of shareholders’ claims, to date no one has engaged systematically with the question of whose religious sincerity should be attributed to the corporation when shareholders hold heterogeneous, or diverse, religious beliefs.

One possible solution to the problem might be to allow ordinary private ordering to address the issue.  The board could designate one share class with the right to control the corporation's religious beliefs about birth control.  So long as the holder of those shares sincerely held the belief, it could settle the question of what religious view to attribute to the corporation.

Hardee takes a hard look at this commodification of religious sincerity and explores how it could harm religious freedom generally.  She creates a framework for considering how to resolve these questions and cautions against using contracts to barter for religious exemptions.

I agree that it's an interesting article, well worth a read. Personally, however, I stand by what I wrote in my articles Using Reverse Veil Piercing to Vindicate the Free Exercise Rights of Incorporated Employers and A Critique of the Corporate Law Professors’ Amicus Brief in Hobby Lobby and Conestoga Wood. Courts should ask whether the corporation's shareholders would be entitled to reverse pierce their corporation's veil. If so, the court should allow the corporate entity to vindicate the shareholder's religious beliefs. If not, then the shareholders' religious beliefs should not be ascribed to the corporation.

Lyman Johnson on Delaware Corporate Fiduciary Duty Law and A Partial Objection

Lyman Johnson has a short but very useful essay on fiduciary duties under Delaware corporate law. His main point follows:

Three distinct actors owe fiduciary duties – executive officers, directors, and controlling shareholders – and numerous aspects of their duties greatly differ.  But Delaware corporate law is not unique in the way many believe.  Conventional wisdom holds that, uniquely, corporate law’s standards of conduct (fiduciary duties) diverge from judicial standards of review, the latter being more deferential.  Yet, the two sets of standards often converge and are identical.  The supposed distinction is not uniformly accurate, and unenforceable standards of conduct may not be “law” at all where standards do diverge.

I concur and urge you to go read the whole thing. But I have to respectfully dissent from the following:

... if a director complies with the duty of care, the business judgment rule standard of review obtains.  If a director breaches her duty of care, the business judgment rule standard does not apply.  The standard of review for the duty of care thus requires that the standard of conduct be fulfilled.  The former is not more forgiving, it is equivalent in its demands, again pointing toward convergence, not divergence.

To be sure, Lyman could point to Justice Horsey's Technicolor decision as support for his interpretation:

To rebut the rule, a shareholder plaintiff assumes the burden of providing evidence that directors, in reaching their challenged decision, breached any one of the triads of their fiduciary duty—good faith, loyalty or due care. If a shareholder plaintiff fails to meet this evidentiary burden, the business judgment rule attaches to protect corporate officers and directors and the decisions they make, and our courts will not second-guess these business judgments. If the rule is rebutted, the burden shifts to the defendant directors, the proponents of the challenged transaction, to prove to the trier of fact the “entire fairness” of the transaction to the shareholder plaintiff. [Cede & Co. v. Technicolor, Inc., 634 A.2d 345, 361 (Del.1993).]

As I explain in my book Corporate Law:

Notice how the justice puts the cart before the horse. Directors who violate their duty of care do not get the protections of the business judgment rule; indeed, the rule is rebutted by a showing that the directors violated their fiduciary duty of “due care.” But this is exactly backwards. Under the abstention theory of the business judgment rule, the rule’s core purpose is to prevent precisely what Technicolor requires. Recall that the rule prevented Shlensky from even getting up to bat with his care claims. The business judgment rule thus precludes courts from asking the question of—let alone deciding—whether the directors violated their duty of care. In contrast, under Technicolor the business judgment rule’s primary function is the procedural task of assigning burdens of proof. In that limited guise, moreover, the rule merely assigns to plaintiff the burden of establishing a prima facie case—the same burden plaintiff bears in all civil litigation. If plaintiff fails to carry that burden, the business judgment rule requires the court to dismiss the lawsuit without inquiry into the merits of the decision. But so what? Under this conception, the business judgment rule is nothing more than a restatement of the basic principle that the defendant is entitled to summary judgment whenever plaintiff fails to state a prima facie case. At best, Technicolor thus trivializes the rule.

By opening the courthouse door to care questions at the outset of the litigation, however, Technicolor went beyond merely trivializing the rule to gutting it. Arguably, Technicolor broadened the scope of judicial review of board decisionmaking to reach not just the process by which the decision was made but also the substance of the directors’ decision. Significant consequences follow from this distortion of the business judgment rule. It is commonly held, for example, that mere allegations of director impropriety do not entitle plaintiff to discovery.[1] Yet, one can plausibly read Technicolor as authorizing precisely the sort of fishing expeditions the business judgment rule was intended to prevent.

Technicolor can be reconciled with the mainstream of business judgment rule analysis only by interpreting the duty of “due care” as being limited to the adequacy of the decision-making process. At several points in the opinion, Justice Horsey in fact so characterized that duty.[2] In addition, numerous Delaware precedents interpret the requirement of due care as being limited to questions of process.[3] Yet, nothing in Technicolor explicitly limits its references to the duty of care to the decision-making process. Arguably, the cart remains before the horse.

Incorporating Catholicism: Dioceses are changing their secular legal forms to conform to canon law and insulate assets

Crux reports: 

As dioceses across the country continue to face multi-million dollar payouts related to clerical sex abuse, some bishops have relied on advice from lawyers to reconfigure the property of their dioceses into charitable trusts.

The practice - which has been implemented by several dioceses after the clerical sex abuse revelations of the early 2000s - creates significantly different outcomes for dioceses and abuse victims in the case of bankruptcies.

Critics say the moves shield assets that could be paid to victims of clerical abuse and may even be illegal. However, Church officials defend the practice, saying their actions were intended to better align the dioceses’ corporate status with canon law. Other dioceses say they acted to ensure the long-term viability of the Church.

It strikes me that both the critics and the defenders are correct. In an article I coauthored with former student Aaron Cole, I argued that the corporation sole--a common form of legal organizations used by Catholic dioceses in the US was incompatible with canon law:

… the Church, as a matter of doctrine and canon law, is composed of numerous united but distinct entities, subject in varying ways and degrees to ecclesiastical control.  Each separate entity possesses rights (including rights of ownership) that are enforceable, under church law, against the other entities.  The assets of the Catholic Church, under canon law, thus do not belong to a single owner. Instead, Church assets “belong to many owners: the Apostolic See, individual dioceses, institutes of consecrated life, societies of apostolic life , parishes, other public juridic persons, private juridic persons, and natural persons individually and in association.”

Accordingly, centralization of “ownership and control of all church property within a diocese is contrary to the law of the Church.”  The use of a corporation sole to hold title to the ecclesiastical property of the juridic persons within the diocese’s territory thus is a significant distortion of the Church’s polity. Indeed, in 1911, the Holy See told the American bishops that it disapproved of using a single corporation sole as some legal owner of all property within a diocese; indeed, the Holy See encouraged the separate incorporation of individual parishes.  Presumably, the same would be true where a diocese civilly incorporated using some other statutory form, such as a nonprofit or religious corporation, holds secular legal title to the ecclesiastical property of all juridic persons within the diocese.

Second, incorporation as a corporation sole exposes the assets of parishes and other juridic persons, which in canon law are the property of such persons, to the claims of creditors of the diocese. Conversely, by centralizing civil ownership in a single entity, the corporation sole also exposes “all parochial and other church-related assets within a diocese to satisfy creditors’ claims against any individual parish or institution.”  Again, the same concerns would arise where a diocese civilly incorporated as a nonprofit or religious corporation claiming secular legal title to the ecclesiastical property of parishes and other juridic persons within the diocese.

The reorganization into a trust format thus is an appropriate response to a longstanding canon law problem. 

But the reorganization also responds to the liability exposure the corporation sole created:

… bishops whose dioceses are incorporated as a corporation sole have argued that they hold legal title to parish assets in trust and for the benefit of the parish.  This line of defense was prominently tested in the Archdiocese of Portland’s bankruptcy case.  The Archdiocese had been incorporated as a corporation sole under Oregon law.  Only one of the 124 parishes with the Archdiocese had been separately incorporated.  The three Catholic high schools within the Archdiocese were not separately incorporated.  When the Archdiocese declared bankruptcy under the weight of numerous priest sex abuse claims, the Archbishop claimed that the bulk of the Archdiocese’s assets were in fact held in trust for the benefit of the unincorporated parishes and other juridic persons within the diocese.

The Bankruptcy Court first held that the freedom of religion clauses of the First Amendment did not deprive the court of jurisdiction over the question of whether the assets purportedly held in trust were properly part of the bankruptcy estate and thus subject to the claims of the Archdiocese’s creditors.  The court then held that those same clauses did not require the court to defer to canon law in determining the ownership of the assets in question.  Next the court held that Oregon state corporation law likewise did not require the court to defer to canon law in determining the ownership of the assets in question.

Turning to the merits, the court noted that “[e]ven debtor’s own canon law expert acknowledges that being a separate juridic person under canon law does not give that juridic person a civil law identity.”

In fact, unincorporated religious associations are not legal persons that may take title to real property in their names. Because the parishes are not separately incorporated, as they could be under Oregon religious corporations law, they cannot hold title to real property. They are not separate from, but are merely a part of debtor.

The court also rejected the Archbishop’s argument “that, even if the parishes are not legal entities that can hold title to real property, they have sufficient legal existence to allow them to be beneficiaries of a trust.”

The reorganization presumably is intended to solve that problem by creating real trusts.

Is there anything wrong with what the Church is doing? The tragic dilemma of the priest sex abuse scandal is the inherent tension between providing just compensation for victims and preventing litigation from creating an existential threat to the Church. 

As Cole and I explained:

In many dioceses, there are hundreds of separate juridic persons, each ministering to numerous worshippers and even non-Church members. If a court were to treat all of those juridic persons as alter egos of the diocese, the assets of many parishes and other ministries that had no connection with priest sex abuse would be made available to satisfy the claims of sex abuse plaintiffs. Inevitably, execution of a judgment against their assets would impede, if not destroy, the ability of these ministries to serve the needs of their congregants. Indeed, the mere threat of liability might do so: “Both church and society will suffer if the continuation of ministries prompted by compassion—ministries often involving risks—is stopped short by the nervous calculation of legal liabilities.”